CS The statement of cash flows is a vital financial document that complements the income statement and balance sheet by providing a clear picture of a company’s cash inflows and outflows over a specific period. Unlike the income statement which mainly focuses on profitability based on accrual accounting, the statement of cash flows deals strictly with actual cash movement. This distinction makes the scf crucial for understanding a company’s financial health in a more practical sense. The scf is segmented into three key sections which include Cash flow from operating activities, Cash flow from investing activities, and cash flow from financing activities. By analyzing each section of the statement of cash flows, stakeholder can gain valuable insight into liquidity, solvency, and financial flexibility.
The indirect method is the more common method and starts with the net income figure from the income statement. Adjustments are then made to account for non-cash expenses (like depreciation) and other accrual accounting items to arrive at the actual cash flow from operating activities (CFFO). First you start with the net income, then add back non-cash expenses, adjust for changes in working capital, and lastly arrive at cash from operating activities.
BH The purpose of a statement of cash flows is to keep track in inflow and outflow of cash. This is important for businesses under an accrual based accounting system, where an income statement might not accurately represent cash inflow and outflow. This is important in showing a business’s free cash flow, which is a facet of financial health that relates to how much cash a business has ready to invest in sudden business oppurtunities. There are three types of cash flows shown on a cash flow statement: cash flows from operating activities, cash flows from investing activities, and cash flows from financing activities. Cash flow from operating activities starts with net income from the income statement, but it adds back or subtracts any revenues or expenses that were accrued but did not involve transfer of cash. This is to accurately display cash inflow and outflow, rather than accrual. Any gains or losses to net income that occured from non-operating activities are also removed. Cash flow from investing activities includes plant assets, bonds, stocks, and other investments. To calcuate cash flow from investing activities, simply state any gain or loss of cash that is related to investing activites. The process is similar for cash flow from financing activities, which includes long-term liability and equity acccounts.
When it comes to direct versus indirect, the differences lie in the cash flow from operating activities. For the direct method, that section simply looks like an income statement created by the cash method of accounting. At face value, it is simpler, because you don’t have to look at or calculate adjustments for cash flow versus accrual. However, unless you are running a business under a cash method accounting system, the indirect method is easier for accountants to create, since it draws from numbers shown on the income statement and balance sheet.
